1. Field of the Invention
The present invention relates to a system and method for predicting, comparing and presenting the cost of a liability versus insurance and, more particularly, a system and method for predicting, comparing and presenting the cost of self insurance versus insurance, and for creating bond financing when advantageous.
2. Description of the Related Art
Insurance and Self Insurance.
In recent years, changes in law, claims handling, managed health care and computers have changed the economics of self insuring versus insuring liabilities. Numerous public and private entities are reviewing the cost and effectiveness of their current insurance and self insurance programs.
In many states, private insurers have historically been prohibited from writing insurance coverage for public entities. These prohibitions most often applied to workers compensation coverage. Recently several states have changed these laws, allowing many public entities to choose between self insurance and private coverage for the first time.
Analysis of insurance and self insurance alternatives has tended to fall into two groups: rules of thumb applied by insurance brokers and carriers, and detailed actuarial analysis performed by actuaries or accounting firms.
Using rules of thumb is a quick and easy method of estimating insurance premiums or ultimate self insurance cost. However, it tends to make similar predictions for very different clients and can vary from actual insurance quotes or self insurance costs by over 50%. Since a cost comparison focuses on the difference between two cost projections, small errors in either projection can lead the client to mistakenly pursue the more expensive course of action.
Detailed actuarial analysis is more accurate and more tailored to the individual client. However, actuaries will generally analyze insurance quotes which are complete and already offered; they will seldom try to predict pricing or assist in the negotiation process. Thus, considerable time, money and effort is expended in marketing, negotiation and analysis before any conclusions or recommendations are reached.
Prior to the present invention, no known system has been able to take into account the large number of input variables used by the present invention to analyze the cost of insurance and self insurance alternatives for property and casualty coverages. These input variables include: client's tax rate, client's borrowing rate, carriers' returns on investments, payout pattern under self insurance, payout pattern under insurance, claims audit data, industry loss data, industry loss development patterns, self insurer fees, premium taxes, carrier administrative expenses, carrier profit, broker commissions, consulting fees, claims handling fees, internal administration costs, legal fees, premium finance charges, client's debt or borrowing limitations, client's debt rating, regulatory requirements regarding the client's purchase of insurance, client's budget constraints, and client's financing objectives.
Clients switching from self insurance to insurance typically require a large additional amount of cash in the first years of insurance. Completely paying off old self insured liabilities takes years, from a low of 3-4 years for property liability, to as much as 60 years for workers compensation. During this 3 to 60 year period, the client is paying for both insurance premiums and old self insured losses.
Problems With Premium Financing.
For many clients, particularly public entities with tight budgets, short term cash flow constraints have prevented moving to an insured program which is much less expensive in the long run. Carrier premium financing beyond three years is rare. Though many claims will take over 10 years to pay completely, no carrier-sponsored premium financing lasts that long.
Credit risk is a primary reason why insurance companies are so reluctant to finance over longer periods of time. If an insured misses payments during the policy term, an insurance carrier can cancel the remainder of the policy. If an insured misses payments after the policy term is over, there is no remaining coverage for the carrier to cancel; the insurance carrier must continue to pay claims while trying to collect the delinquent premium finance payments. Most premium finance contracts which extend beyond the policy term require excellent credit, collateral, or both. Premium finance companies who have not obtained collateral find themselves far down the line of creditors when a borrower enters bankruptcy proceedings.
Deductible plans are one method which has become popular for allowing insureds to pay for liabilities over many years. In a typical deductible plan, an insurance carrier pays all losses for the client and then seeks reimbursement for payment up to a specified amount per claim. Thus, Client X might have a deductible insurance policy with Insurance Carrier Y where Carrier Y pays all losses and seek reimbursement for the first $250,000 per claim from Client X.
Deductible plans have several drawbacks. The most prominent drawback is that while the client is able to spread payment over many years, they assume the risk that losses will be worse than anticipated or pay out faster than anticipated. These risk results in problems very similar to those encountered in self insurance: the client may have difficulty making large, unexpected loss payments; the client may reorganize or sell parts of its operations and find it very difficult to allocate costs or get reimbursement from departments or subsidiaries; uncertain liabilities make it more difficult to sell a portion of a company or to privatize a portion of a public entity; often costs paid under deductible plans are charged back years later to a department whose management did not cause and cannot control the cost of a particular claim; and, insurance carriers usually administer deductible plans for their clients, in effect the insurance company is able to write checks from the client's bank account.
Insurance regulators in most states require carriers to set aside reserves for amounts outstanding under premium financing and deductible plans, unless specified types of collateral are used. These reserves are applicable even for clients whose long-term credit is rated AAA by Standard & Poor's (S&P) or Aaa by Moody's. In many states, collateral from the insured is required in all cases.
Long term financing for guaranteed cost insurance would give clients the best of both worlds, a long term payout and guaranteed cash flows. Unfortunately, current premium financing methods make long term financing difficult. As mentioned above, moving from self insurance to insurance normally requires an outlay of more cash in the first few years than staying self insured. Clients without enough cash to cover the transition who cannot obtain desirable premium financing have two primary options: bank financing and bond financing.
Bond financing is a particularly attractive way for public entities to finance long term liabilities. However, to date, no bonds have been issued to pay for insurance premiums for property, casualty, or employee benefit premiums.
Bonds have been issued to pay for unfunded pension liabilities (see "Pension Bonds May Be Worth The Risk", American City & County, vol 111, no. 6, p. 6, May 1996). These bonds pay off an unfunded pension liability over many years and typically pay taxable interest even if issued by municipalities.
Pension bonds primary purpose is interest rate arbitrage. Interest paid to the bondholder on pension bonds is typically taxable. Even taxable municipal bonds typically pay interest rates below the investment returns obtained by pension funds. The difference between the pension fund's investment yield and the interest rate on the bond reduces the municipality's pension cost. The municipality is betting that the pension fund will earn a higher return than the interest on the bonds; it is entirely possible that the pension fund will earn a lower return than the bond interest.
A $1 billion bond, according to the present invention, which would allow the County of Los Angeles to move from workers compensation self insurance to insurance would likely save the County over $500 million dollars as a result of insuring this liability and using bond financing for this purpose. Such a bond is expected to yield tax exempt interest, unlike pension bonds, and further reduce the County's cost. The bond will not be subject to the County's borrowing limit, and will not require voter approval. Since this invention will save numerous public entities and other employers large sums of money, it is clearly in the national interest.
Accordingly, it is an object of the present invention to provide a method of insuring and financing currently self insured liabilities, while taking into account constraints imposed by laws, regulations, leases, outstanding bond issues and budgets.
It is another object to provide a system for creating long term premium financing which is tailored to the needs of a particular client.
It is another object to provide a system and method which predicts the cash flows which an insurance company would encounter in insuring an entity's liabilities, using data on: the entity's recent loss experience, any actuarial studies of losses, industry loss experience, expenses for handling losses, effectiveness in handling losses, and the insurance company's expected savings from efficiencies.
It is another object to provide a system and method for using expected cash flow data for an insurer, along with the insurer's administrative fees and interest rate for discounting, to predict premiums for insuring currently self insured or uninsured liabilities.
It is another object to provide a system and method for calculating both total savings and savings by budget year obtained by insuring the formerly uninsured or self insured liabilities of the employer.
It is another object to provide a system and method for comparing the costs, regulatory feasibility, and budget feasibility of paying insurance premium using: cash, carrier premium financing, bank or finance company premium financing, and bond issuance.
It is another object to provide a system and method for calculating the payment patterns for financing which fit the employer's desire to: either make premium finance payments at a percentage of the current annual budget until the premium liability is extinguished, or make premium finance payments at a percentage of what expected future loss and expense payments would have been under self insurance or uninsurance.
It is another object to allow employers to choose an arbitrary payment pattern for premium financing, and to adjust either the length of financing or individual payments until the present value of the payment stream matches the premium being financed.
It is another object to provide a system and method for public entities to save substantial amounts of money by taking advantage of the spread between the tax exempt financing rates available to public entities and the taxable rate of return on insurance carriers' investments which will be used for calculating the premium(s) charged to the public entity.
It is another object is to automatically provide an estimate of ultimate losses and loss payout patterns for a self insured or uninsured liability using industry actuarial data and the public entity's current loss evaluation, even if the client does not have a recent actuarial analysis or has not kept historical loss data.
It is another object to reduce the time required to market insurance coverage by providing expected loss, expense, payment patterns, discounting for the time value of money and premiums to insurance carriers.
It is another object to evaluate the loss rates of the employer versus similar employers and to use this data in estimating the savings available by insuring the liability.
It is another object to provide output which allows the governing body of the employer to easily see the total savings, present value of savings, and annual budget savings obtained by insuring a currently uninsured or self insured liability.
It is another object to provide analysis and output which can be used in legal validation proceedings which are sometimes required for a public entity to finance premiums over multiple years.
It is another object to allow public entities which have not set aside funds to pay for outstanding uninsured or self insured liabilities to insure these claims for a lower total cost and a lower expenditure in each budget year.
It is another object to provide public entities with a financing mechanism which guarantees cash flows for property and casualty liabilities.
It is another object to facilitate sale or separation of a portion of a public entity, such as an airport authority or municipal utility, by insuring currently uninsured or self insured liabilities and providing the separated entity a "fresh start" with respect to these liabilities.
It is another objective to provide a system and method which for the first time uses bond financing for insurance premiums which cover property and casualty risks of public entities.
It is another object to calculate premium financing cash flows which fit accounting and cash flow objectives of the company or public entity.
It is another objective to reduce or eliminate an insurance company's credit risk when employers use long-term premium financing.
It is another objective to reduce interest rate risk for an insurance company when employers use premium financing.
It is another objective to allow an entity to transfer existing claims and liabilities to an insurance carrier.
It is another objective to use bond financing for insurance premiums in cases where a debt ceiling would otherwise prevent new bond issuance, by having the liabilities declared a "debt imposed by law" and replacing this debt with the smaller and more certain payment stream of the bond-financed insurance premium.